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Media Coverage, Real Earnings Management, and Long-Run Market Performance: Evidence from Chinese IPOs

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Abstract

This study investigates how real earnings management (REM) in the initial public offering (IPO) year affects long-run post-IPO market performance. The empirical results show that the effect of REM on a firm’s stock returns varies with the forms of REM. Abnormal production costs are positively associated with long-run returns, whereas abnormal cuts in discretionary expenses are negatively associated with long-run returns. These results suggest that investors are not fully aware of the implications of REM and initially undervalue or overvalue the firm based on different REM activities. Further, this study examines the long-run role of the media in the capital market by examining the impact of media coverage on the consequences of IPO firms’ REM practices. The results indicate that the associations between REM and stock returns become weaker if the IPO firm is more visible through the media. Additional analyses show that retail investors are more likely to initially misprice REM activities and be influenced by media information. Compared with media coverage, audit quality or analyst following has a relatively less pronounced effect on the consequences of REM activities. These findings imply that media coverage appears to mitigate the influence of REM on stock returns, facilitating market efficiency after a firm’s IPO in the long run.

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Notes

  1. The average aggregate earnings management is defined as the average country ranking of EM1, EM2, EM3, and EM4. EM1 is defined as the median ratio in country i of the firm-level standard deviations of operating earnings over the cash flow from operating activities (both scaled by lagged total assets), multiplied by -1. EM2 is defined as the cross-sectional correlation in country i between the change in accruals and change in cash flows from operating activities (both scaled by lagged total assets), multiplied by − 1. EM3 is defined as the median ratio in country i of the absolute value of accruals over the absolute value of cash flow from operating activities. EM4 is defined as the ratio in country i of the number of firms reporting small profits over the sum of the number of firms reporting small losses and profits. A smaller profit (loss) is defined as a value of net earnings scaled by lagged total assets in the range [0, 0.01] ([− 0.01, 0]).

  2. The average earnings opacity is defined as the average country i decile ranking across EM2, EM4, and earnings aggressiveness, where earnings aggressiveness is the median ratio in country i of total accruals over the lagged total assets.

  3. The CSMAR and the RESSET are two leading economic and financial data providers in China.

  4. China Securities Regulatory Commission suspended IPO from November 2012 to November 2013, so only two firms were listed in 2013. These two IPOs are excluded from the sample due to a lack of necessary data to estimate REM measures.

  5. The IPO firms and other firms conducting an IPO or SEO firm in the year are not included in the regression.

  6. The Chinese listed firms are required to release their audited annual reports by the end of the following April.

  7. In untabulated tests, I investigate whether the effect of media coverage varies with the types of media sources. I classified media into two categories: state-controlled and market-oriented, based on the ownership structure and control rights shown in the company disclosure, newspapers’ websites, and government press releases. The results report that the effect of media coverage on the relationship between REM activities and long-run stock returns is more pronounced when the news reports are from market-oriented media. One possible reason is that information from the market is more comprehensive and accurate (You et al., 2018), improving investors’ understanding of managerial earnings manipulation.

  8. In the untabulated analysis, I test the relationship between REM and subsequent operating performance (∆ROA) using the other three REM measures (N_ABDISX, N_ABCFO, and TREM). The results report negative coefficients of these measures, qualitatively similar to those reported in Table 4. These results support the expectation that investors are not fully aware of these REM activities and initially overvalue the firm based on these REM activities, leading to negative associations between these REM activities and subsequent stock returns.

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This research did not receive any specific Grant from funding agencies in the public, commercial, or not-for-profit sectors.

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  1. Graduate School of Economics, Osaka University, 1-7, Machikaneyama, Toyonaka, Osaka, 560-0043, Japan

    Danning Yu

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  1. Danning Yu
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Appendix

Appendix

See Table 10.

Table 10 Variables and definitions
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Yu, D. Media Coverage, Real Earnings Management, and Long-Run Market Performance: Evidence from Chinese IPOs. Asia-Pac Financ Markets 30, 729–760 (2023). https://doi.org/10.1007/s10690-022-09396-2

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